Utilizing Tax-Free Gifts for Wealth Transfer

November 10, 2021

Simple planning strategies can be highly effective in transferring assets out of your taxable estate.

Recent federal spending proposals have created considerable uncertainty regarding future tax laws, including those governing the federal gift and estate tax. The federal gift and estate tax exemption is currently $11,700,000 for gifts made, or decedent’s dying in 2021. A recent Democratic proposal provides for reducing this exemption to $6,020,000 as of January 1, 2022. Other prior proposals have reduced the amount to as low as $1,000,000 for the gift tax exemption and $3,500,000 for the estate tax exemption. Although it is unclear whether any of these proposals will ever be enacted into law, certain estate planning techniques can be utilized currently, and should likely be available in future years, which allow taxpayers to transfer significant wealth to heirs without using the federal gift and estate tax exemption.

A simple way for taxpayers to transfer significant wealth over time is to make annual exclusion gifts and payments for educational or medical expenses on behalf of others. These “tax-free” gifts are allowed under current law, and the most recent tax proposals as disclosed to date do not propose to limit them.

Annual Exclusion Gifts

Under current law, every individual can give away up to $15,000 per year to as many individuals as he or she wants without using any federal gift and estate tax exemption. The $15,000 amount is indexed for inflation, which will allow for potential increases to this annual amount in future years. A married couple can each give $15,000 to the same individual such that the total annual exclusion gifts which may be made by spouses to any one individual is $30,000. If a couple has three children, they can give $90,000 away in annual exclusion gifts to their children each year without consuming any portion of their lifetime exemptions. If the couple makes gifts prior to the end of 2021 and in the beginning of 2022, that will allow a total of $180,000 to be gifted tax-free to their children over the next few months.

These transfers do not have to be outright. A variety of trusts for the benefit of family members (e.g., children, grandchildren, nieces, nephews) can qualify to be the recipients of annual exclusion gifts. Establishing such trusts can provide several advantages, including:

  • Protecting the assets from the beneficiary’s creditors
  • Providing the opportunity to avoid federal transfer taxes on the trust property for generations
  • Having a vehicle for other planning techniques, such as loans or sales (if beneficial under future law)

The following hypothetical example highlights the potential effectiveness of making annual exclusion gifts over time:

A married couple creates one or more trusts for the benefit of their two children and five grandchildren. In Year 1, the couple gifts $30,000 to a qualifying trust for each child and grandchild for a total of $210,000. In Year 2, the couple gifts the same amount, for an aggregate total of $420,000. Assuming these annual gifts are made on January 1 of Year 1 and Year 2, and each year thereafter, and invested in a moderately aggressive portfolio realizing an annual rate of return of 5.5%, the potential growth may be significant, as shown below.

Hypothetical: Compounding Benefit of Gifting

Annual Gifts
(7 Recipients x $30,000 each)
Compound Annual Growth (5.50%) End-of-Year Cumulative Value ($)
$210,000 $11,550 $221,550
$210,000 $23,735 $455,285
$210,000 $36,591 $701,876
$210,000 $50,153 $962,029
$210,000 $64,462 $1,236,491
Year 5 $1,050,000
$210,000 $79,557 $1,526,048
$210,000 $95,483 $1,831,530
$210,000 $112,284 $2,153,814
$210,000 $130,010 $2,493,824
$210,000 $148,710 $2,852,535
Year 10 $2,100,000
$210,000 $168,439 $3,230,974
$210,000 $189,254 $3,630,228
$210,000 $211,213 $4,051,440
$210,000 $234,379 $4,495,819
$210,000 $258,820 $4,964,639
Year 15 $3,150,000
$210,000 $284,605 $5,459,245
$210,000 $311,808 $5,981,053
$210,000 $340,508 $6,531,561
$210,000 $370,786 $7,112,347
$210,000 $402,729 $7,725,076
Year 20 $4,200,000

Source: Neuberger Berman. Assumes a 5.50% annualized rate of return. The hypothetical illustration is for informational and education purposes only and based upon a hypothetical straight-line 5.50% annual growth rate assumption which is reflective of Neuberger Berman’s moderately aggressive asset allocation model (without alternatives). These hypothetical returns are used for illustrative purposes only. They are not intended to represent, and should not be construed to represent, a prediction of future rates of return. The illustration does not reflect the fees and expenses associated with managing a portfolio. If such fees and expenses were reflected, results shown would be lower. Investing entails risks, including possible loss of principal.

If desired, spouses of children and grandchildren may be added as donees of the annual exclusion gifts and as beneficiaries of the trusts. By expanding the class of beneficiaries, even greater federal gift and estate tax savings can be achieved.

The transfer tax savings on these gifts can be measured by the federal (and state) estate tax rate multiplied by the future value of the gifts in the year of death. Assuming a combined federal and state estate tax rate of 45% (although this rate may be higher in future years) and a future value of the gifts, as set forth above in Year 20, in the amount of $7,725,076, transfer tax savings in the year of death in that year would be $3,476,284. Further, at the end of the 20-year period, the donors will have gifted $7,725,076 to one or more trusts for their heirs, allowing the heirs access to the funds without an associated transfer tax burden.

It should also be noted that annual exclusion gifts can be used to fund 529 plans (which are named after the section of the Internal Revenue Code that governs them). These plans can be established to help individuals save for and pay the costs of education, including college and expenses of qualifying private, public and religious institutions offering a kindergarten through 12th grade education. As a bonus, individuals are permitted to “superfund” a contribution to a 529 plan with up to 5 years of annual exclusions in one year. In 2021, gifts totaling up to $75,000 per beneficiary ($150,000 for married individuals) are now allowable to be transferred into such plans.

Payment of Educational and Medical Expenses

Significant transfer tax savings can also be achieved by taking advantage of the exemption allowed for certain payments for educational and medical expenses. Under current law, any amount paid on behalf of an individual as tuition to an educational organization, or to any provider of medical care with respect to such individual, is not treated as a transfer of property for gift tax purposes. For the gifts to qualify under this exception, the payments must be made directly to the educational or medical provider. Reimbursements to the individual for these expenses will not qualify.

Given the high cost of private elementary/secondary school and college, meaningful savings can be achieved by paying tuition on behalf of other individuals. Assume that grandparent has five grandchildren attending private colleges and universities with a tuition of $55,000 per year for four years. Total tuition for each grandchild would be $220,000. Total tuition for all five grandchildren would be $1,100,000. Ignoring the future value of these tuition payments and applying a federal and state estate tax rate of 45%, the transfer tax savings would be $495,000, and the grandparent’s exemption will not have been consumed.

Conclusion: Benefiting from Existing Transfer Tools

For individuals looking to take advantage of current (and likely future) tax laws, annual exclusion gifts and transfers for educational and medical expenses can yield significant gift and estate transfer tax savings. In our view, it’s important not to overlook the benefits of establishing and maintaining a regular gifting plan utilizing these tax tools.

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Neuberger Berman is not providing this material in a fiduciary capacity and has a financial interest in the sale of its products and services. Neuberger Berman, as well as its employees, does not provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. Diversification does not guarantee profit or protect against loss in declining markets. As with any investment, there is the possibility of profit as well as the risk of loss. Investing entails risks, including possible loss of principal. Unless otherwise indicated, returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.

This material is informational and educational in nature, is not individualized and is not intended to serve as the primary or sole basis for any investment or tax-planning decisions. Nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation or solicitation to buy, sell or hold a security. Hypothetical growth illustrations are for informational and educational purposes only. Examples are based in part on various assumptions, projections or other information generated by Neuberger Berman regarding investment outcomes. Growth rate assumptions and projections are hypothetical and do not reflect actual investment results and are not guarantees of future results. Calculations are based upon Neuberger Berman’s asset allocation models and capital market assumptions, which are updated periodically. Changes in assumptions would impact the hypothetical results shown. Actual results may vary significantly and actual growth rate may be higher or lower, including negative growth (i.e., investments lose value), than any hypothetical scenarios shown. Estimated returns should not be used, or relied upon, to make investment decisions.

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